Is China’s Economy Inflating a Stock Market Bubble?

The People’s Bank of China (PBoC) announced yesterday that it’s easing the reserve ratio requirement (RRR) for all banks by 100 basis points to 18.5%. The RRR is the amount of depositor’s money that banks must have on hand in order to issue out loans.

This will allow banks to inject a further US$210 billion into the Chinese economy. The move sees an attempt by the PBoC to boost a flagging economy, which is set to grow by 7% this year — down from 7.4% in 2014.

Increasing the amount of money in the system will also ease pressure on the risk of deflation. And that’s something they’ll want to keep in check. China is fearful that consumers will put off spending in the expectation of lower prices in the future. That would put a stop to any hopes of a consumer driven recovery.

The PBoC made further cuts to the RRR to 18% for banks lending to small businesses and the agricultural industry. This provides the market with clear signals about where the PBoC feels the new money should end up.

The Shanghai stock exchange set to grow to new heights

But the cut to the RRR is also raising fears that the new money flooding into the market could fuel the stock market bubble to dangerous levels. This is the biggest cut to the RRR since 2008, when the Global Financial Crisis led to banks restricting the amount of capital available for lending.

The Shanghai Stock Exchange (SCE) has doubled in value in the past year, pushing upwards of US$3 trillion in market capitalisation — the total value of all shares in the market.

ANZ Bank believes that China could miss its 7% growth target this year, even with this bold round of monetary easing. They also think that the PBoC will make a further 0.25% cut to the RRR rate by July.

For investors looking for yields in the stock market game, the SCE is likely to see strong growth over the next three months. But if you’re more concerned about what it means for Australian commodities exporters, the answer is less optimistic. This move is a clear order to lenders: stoke consumers into spending more. Iron ore exports won’t rebound as a result of this policy, and the Australian economy is unlikely to see any benefit from it.

So while an influx of new money into China’s economy sounds like a good thing for us at face value, it’s not going to prevent us from further pain this year. The Daily Reckoning’s Greg Canavan says that we’re heading for an inevitable recession in 2015.

To find out how you can protect your stock portfolio from the fallout of the imminent recession, you need to read Greg’s free report ‘Australian recession 2015: Why it’s unavoidable and the quickest way to protect your wealth’. For details on how to download your free copy of his report, click here.

The Daily Reckoning offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, The Daily Reckoning delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors. Founded in 1999, The Daily Reckoning is published in 7 countries with a worldwide readership of almost 1 million people.

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